Valve Crashes Microsoft’s Holiday Gaming Party

This coming holiday season is important for Microsoft (MSFT[1]) and Sony (SNE[2]). Both technology giants are releasing next-generation video game consoles just in time for Christmas shopping.

MSFT and SNE sold 80.4 million and 78.2 million units of their Playstation 3 and Xbox 360 consoles and Nintendo (NTDOY[3]) — the venerable Japanese game maker that sold more than 100 million of the previous generation Wii consoles — is badly stumbling with its Wii U follow up[4]. The Xbox One and Playstation 4 seemed poised to deliver killer holiday quarters, and we’ve even been speculating about the possibility Apple (AAPL[5]) might play spoiler with a games-enabled Apple TV[6], but that’s a bit of a long shot.

Now Valve has pulled the trigger on its long-awaited Steam Box initiative and is crashing the video game console party. And while Sony will take a hit if the Steam Box succeeds, Microsoft is the one that seems to be directly in Valve’s crosshairs.

We’ve written about Steam Box before. Valve was making noise about it last year[7], and it teased its upcoming video game streaming device — the Steam Box — at this year’s Consumer Electronics Show.

Until recently, it had all been rather nebulous and smelled faintly of an attempt to distract from the upcoming next-gen video game console launches. It’s no secret Valve has been unhappy with Microsoft’s decisions of late, particularly the move to an online app store with Windows 8 that threatens Valve’s Steam business of selling PC games online. Valve founder and CEO (and former Microsoft employee) Gabe Newell went on record last year as saying “Windows 8 is a catastrophe for everyone in the PC space.[8]”

Historically, several key issues have held PC gaming back from displacing video game consoles:

PCs were expensive and oversized compared to consoles. No one wants a massive tower PC and all its peripherals in front of the TV. Valve is releasing its prototype Steam Box in October[9], and it’s optimized for the living room. That means it’s small, affordable and powerful enough to play PC games. Multiple hardware manufacturers will be releasing their own versions in 2014 at a variety of price points. Unlike consoles, those systems will be user-upgradable.

PC games featured high resolution graphics requiring HD computer monitors. Playing a PC game on a CRT TV was miserable — if you could get it to work at all. Current 1080p HDTVs and new 4K UltraHD TVs have the resolution and speed to display PC graphics without compromise.

PC games were developed to use the input systems of a computer — namely the keyboard and mouse. Valve just announced the new Steam Controller[10], a wireless device with circular trackpads instead of joysticks, a touchscreen and 16 buttons. It’s designed to replace a keyboard and mouse, although Valve says Steam will continue to support the classic PC setup for users who prefer it.

In addition, Valve has developed its own operating system: Steam OS.

Steam Box gaming PCs run a free, Linux-based operating system that’s optimized for use with TVs along with integration with Valve’s Steam game distribution network. This requires porting titles from its massive game library, at least temporarily blunting the massive back catalog advantage Steam has over new consoles and their slim launch title selection (Valve says major developers are already on board). But in the meantime, the company is promising streaming from an existing gaming PC to the living room as a workaround.

Valve is privately owned, so it’s not an investment opportunity. But, it has the potential to play disruptor in the video game space — a market that’s already seen more than its share of rapid change thanks to mobile gaming on smartphones and tablets — and could ultimately play the role of spoiler to Microsoft’s Xbox One ambitions, not to mention hurting Windows 8.

How difficult could Valve make things for Microsoft? Valve counts thousands of PC games in its Steam platform and claims more than 50 million players. The Verge points out that the strategy Valve is currently embarking on is similar to the approach Google (GOOG[11]) employed with Android to take on Apple’s mobile dominance[12]: Release a free and open alternative operating system, sign up hardware developers to release systems that run that free OS, convince developers to begin releasing games for that growing OS base and provide the online marketplace and distribution network to deliver the games to players.

In Steam, Valve already has a massive, proven distribution network that game developers like — according to Forbes, it accounts for between 50% and 70% of all downloaded PC game sales[13]. Publishers might gross 30% selling PC games through a retailer like Amazon (AMZN[14]), but Steam gives them a 70% cut and the flexibility to offer price reductions and special offers — just like Google Play. Just as tablets have eroded Microsoft’s traditional business PC market, Steam has the potential to cut into home PC sales. In both cases, Windows is squeezed out, as are other Microsoft products like Office.

Steam machines might not be on store shelves for Christmas 2013, but they’re on the way, and they have the potential to crash the Playstation and Xbox release party by convincing gamers to wait. If they catch on, Sony will suffer through slower than hoped PS4 sales, but Microsoft stands to really take hits on its Xbox one and PC gaming fronts.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.